The United States is one of the few countries in the world that has a federal income tax. This means that you must pay taxes, no matter where you live and work, and file your annual returns with the Internal Revenue Service (IRS).
Tax evasion is the attempt to conceal money or information from the IRS or other tax authority through unlawful means. Fines, penalties, and/or imprisonment may be imposed as a result of tax evasion.
Tax avoidance is when someone does something legally to reduce the amount of money they owe. This can be done by taking deductions or credits or by investing in tax-advantaged accounts.
The difference is lying and hiding. If you are caught lying or hiding anything from the IRS, then you are likely to be charged with tax evasion. The IRS will look at various aspects of your business to scrutinize the expenses you are deducting and ensuring that you are capturing all revenue incoming to the business.
New salon owners often think that tips are bonuses outside of their income earned and therefore not entitled to have to pay tax on them. Tips are income. If you do get audited, the IRS will look to see if you have appropriately tracked your service and tip income. They have algorithms that they use to estimate the number of hours worked per week * average service $ * average tip amount. If your yearly tips fall outside of an acceptable range, they may further audit your book or penalize you with taxes for the current year AND possibly back taxes for previous years.
If a new salon fails to pay taxes on their tips and they are audited, the back tax and penalties could be huge. If we take an example of an average salon earning $50k and 20% of the income is from tips, the back tax and penalty could be as more than $3-5k! If the salon did this for 5-10 years, the back tax alone could be $15-50k! That's how critical it is to file income from tips with the IRS.
Salon owners can work to reduce their taxable income by making sound decisions on how they conduct business, but if you are caught not paying salon taxes out of your control, be prepared for heavy fines and penalties.
The United States taxes all income, regardless of where it is earned or who earns it. If a company fails to report their tips to the Internal Revenue Service (IRS) and they are audited, the back taxes and penalties can be huge. Salon owners should make sure that they track their income from service, tips, merchandise sales and expenses. Thorough bookkeeping by using Salon Accounting in these areas year round can help streamline an audit and help make sure business owners avoid paying penalties and fines.